Shops and the city

We report three findings: (1) Using evidence from national chain bankruptcies, we show that large retailers have significant positive effects on nearby establishments that decay quickly with distance. (2) Local governments respond to the size of these externalities. When a town’s political boundaries allow it to capture a larger share of retail spillovers, it is more likely to offer retail subsidies. (3) These subsidies, however, crowd out private-sector mechanisms that also subsidize large retailers, such as shopping malls. Together these facts provide powerful evidence of the Coase theorem at work and highlight a concern for local development policies even when externalities can be targeted.

Local Governments and Retail Externalities

The Concise Encyclopedia of Economics begins its article on public goods and externalities (Cowen, 1993) with the statement that “[m]ost economic arguments for government intervention are based on the idea that the marketplace cannot… handle externalities.” The article proceeds to explain that “markets often [do] solve (..) externalities problems” when property rights are well defined (as in Coase, 1960). This idea, that there are often both public and private mechanisms for internalizing externalities, has been central to public finance but difficult for empirical researchers to observe in all of its implications. There are few situations where an externality can be identified in a dataset, fewer where the relative size of this externality can be correlated with policy decisions, and fewer still where these decisions can be explored alongside alternative private internalization systems.

In this paper, we study precisely such externalities, policies, and private mechanisms in detail. We set out by estimating the size of a specific type of externalities: the spillovers produced by big-box retail stores. The question of whether and how much they affect the number and size of businesses surrounding them is a contentious one that is of interest to economists and policymakers alike. To estimate the size of these externalities, we exploit the nation-wide store closings associated with the bankruptcies of national chains of bookstores (Borders), department stores (Mervyn’s), electronics stores (Circuit City Stores and CompUSA), and housewares stores (Linens ‘n Things). We contrast the sudden, locally exogenous disappearance of the stores affiliated with these chains with the continuing presence of stores associated with comparable chains in the same sectors (Barnes & Noble, Kohl’s, JC Penney, Best Buy, and Bed Bath and Beyond). Using geographically detailed data on both establishments and consumers we find robust, positive spillovers at the short distances relevant for municipalities. In the presence of a big-box store, other businesses flourish. There are more of them, and they employ more workers. This happens because when consumers visit the big-box store, they also visit nearby stores that they would not otherwise have visited.